Why Real Estate is the IDEAL Investment

Why Real Estate is the IDEAL Investment

So… Why is Real Estate is the I.D.E.A.L. Investment?

The first thing I’d like to discuss with you before we even get into the techniques of real estate investing is why should you even bother with real estate. What is it that makes this such a great way to become wealthy? Real estate has been called the IDEAL investment because what it produces spells the word…IDEAL.

Investment real estate gives you: Income, Depreciation, Equity, Appreciation and Leverage.

screen-shot-2016-11-30-at-12-21-17-pm“I” is for INCOME

Real estate entrepreneurs enjoy income in the form of cash flow created by rents, lease payments, option fees, pet rent (yes, rent for Rover), extra-resident rent (Uncle Joe), and even mortgage payments when we provide seller financing. In addition to recurring income streams we also enjoy income in lump sums; some large, some small. These include sale proceeds, option fees, down payments, and balloon payments.

Real estate generates two types of income and each is taxed differently. Ordinary income is income generated from flips, quick turn rehabs, and any property not held for investment longer than 12 months. Rental properties generate passive income which is exempt from self employment tax (currently 15.3%).

The key to passive income is the intent to rent the property and the holding period exceeding 12 months. Talk with your CPA to understand the tax implications of your transactions…it can make a massive difference to your financial future.

When selling properties, I like to use the lease option or lease purchase technique because I’m blending the sale of some rights. One is the right to purchase the property at an agreed price at a future date using an option.  The other is a rental agreement which generates passive rental income.

“D” is for DEPRECIATION

This benefit is unique to anything in the finance world because depreciation is a deductible expense created by investment property. Depreciation allows you to deduct an amount equal to 1/27.5th per year against the income produced by the property. However, if the deduction exceeds the income, the depreciation may be taken against other income or carried forward.

To fully understand this benefit I strongly encourage you to consult your tax adviser. I assure you it will be worth the conversation!

There are many strategies and techniques involving entity structuring that will help you to maximize the tax benefits afforded entrepreneurs who own a business and do not act as a sole proprietor.

“E” is for EQUITY

Equity is that amount of a property that is not pledged as collateral for a debt. The simple way to look at it is if you have a property valued at $150,000 and it has a $100,000 mortgage on it, then you have $50,000 in equity that could potentially be used as collateral for additional financing.

One important thing to note is that many sellers confuse equity with the amount of money they’ll walk away with after a sale. (They seldom consider things like closings costs, commissions, and other seller concessions.) We’ll discuss this in another post.

“A” is for APPRECIATION

I just love appreciation; where else can you make money while you sleep? When things go up in value without any effort on my part that is a good deal! Real estate is cyclical. So, remember friends; it will not go up in a straight line, but over time it always does go up.

Even though the current market is flat in some areas and receding in others we know that over time our real estate will increase in value .However this is not why we buy real estate.

To good investors, appreciation is just a bonus because we make our money when we buy either with great terms or because we buy at below market process. We cannot always predict when or by how much a property will appreciate, so if we buy right, but timing doesn’t allow for appreciation… we still make a profit.

If, however, we do benefit from appreciation, we still make our profit and we get a bonus too! People who buy looking for appreciation are not really investors, they are speculators…they are the dot.com bubble people of real estate.

“L”  is for LEVERAGE

If I’m a new investor just starting out and I go to my stock broker and tell him I want 1000 shares of a $100 stock he’s going to ask me for $100,000. If I don’t have the $100,000, I’m done and there’s no deal.

But let’s say I have a big account of say $500,000.  He may let me margin the securities, which means he’ll lend me some of my own money (about 50 cents on the dollar) to buy the stock.

In this example, I can buy the stock with only $50,000. So looking at the stock market I can get no leverage if I buy 1000 shares for $100,000, BUT, I can get 2 to 1 leverage using a margin account. I could use $100,000 to buy $200,000 worth of stock.

In real estate many lenders will allow me to purchase a property valued at $100,000 with only 10% down. This means that I’d put only $10,000 down and the bank would finance the remaining $90,000.

screen-shot-2016-11-30-at-12-20-36-pmThis would suggest that with $100,000 cash I could control 10 PROPERTIES valued at $1,000,000!

THAT’S RIGHT, $1 MILLION DOLLARS!

If each of these investments appreciated 5% in one year who would have the best return on their investment?

Stock Purchase without leverage $ 100,000 x 5% = $5,000

Stock purchase with leverage 2 to 1 $ 200,000 x 5% = $10,000

Real Estate with leverage of 10 to 1 $1,000,000 x 5% = $50,000

The power of leverage with real estate is unmistakable.

Let’s say you played this out for 10 years. The numbers would be staggering. While there are interest expenses and carrying costs, these will be paid by your tenant. Additionally, your equity would increase as they pay down your mortgage.

It gets even better when you learn techniques like buying with “Seller Financing” or by using existing debt and buying the property “Subject To” both techniques which are near and dear to my heart which will be covered in a future post!

So, are you ready to start making I.D.E.A.L. investments?

To Your Success,

Augie

So You Want To Invest In A Condo?

So You Want To Invest In A Condo?

While I love investing in many types of real estate, for me, different asset classes have different exit strategies. As a general rule, I am not a holder of condos as long term investments but will, from time to time, buy them for resale. My concern with holding condos or town homes as long term investments is the potential for an HOA or condo association to hold too much control over my investment. I am sure there are many very successful condo investors out there so this is not an attack. The asset class just isn’t my first investment choice.

If you want to invest in condos and town homes the key is to recognize some of the potential risks and consider your options in advance. This way you can mitigate surprises before purchasing the unit.

Many people believe owning a condo or town home is easier than owning a single family home because you don’t have to worry about yard maintenance, roof repairs, etc. Compared to buying a single family house there are definite differences with condos. When purchasing a condo you are not only buying your unit. You are also buying an ownership interest in the common areas of the condominium project such as the lobby, grounds, building exterior, etc. With common ownership comes risk and respponsibility.

The following information doesn’t cover everything you need to know, but it is a good start.

Insurance

It is usually a good idea to get a copy of the certificate of insurance, which is a summary of the condo association’s policy. First see if the replacement costs covered by the policy are an accurate reflection of the cost of rebuilding. You’ll want to make sure that the policy has a building-ordinance clause, which means that the insurance will cover the cost of bringing the building up to code if there is any rebuilding to be done.

This is usually more costly in terms of premium but is is much better than not being financially prepared for major repairs (especially when code related upgrades are required). On older buildings, there may have been many building code upgrades since the time of construction. As an example, over the years Florida’s hurricanes have wreaked havoc and many condo investors have suffered significant losses due to extended vacancies while waiting until their association and insurance carriers arranged for and completed repairs.

Finally, make sure that you understand exactly what the association policy covers and what you are responsible for. Typically property and liability insurance does not cover the interior of your unit, but rather the exterior of the building and common areas. You may need to buy your own insurance to protect your interior space and your tenant will need a renter’s policy to insure their belongings.

The HOA

Take a look at the minutes of the condo association board meetings to see what the owners have been griping about. If everyone was complaining about the faulty electrical, plumbing or the landscaper’s absence, you know that the complex is having management difficulties. Even if there aren’t any complaints, reading the minutes will reveal the sorts of projects that are under way at the complex; projects the seller may have neglected to mention. HOA fees pay for expenses such as maintenance of the common areas, insurance (property and liability), non sub-metered utilities, if any (such as water for irrigation and pools or electricity for exterior lighting and gates), repair reserves and more.

Management

I’m cautious of a condo complex whose owners manage the place themselves. Although many are operated efficiently, self-management can lead to more hassles for owners; especially non-occupant owners. If the condo development is professionally managed, check out the management company as thoroughly as you check out the association. Ask other owners. Ask people in nearby buildings. And be sure to interview the day-to-day manager directly. If you get saddled with a bad property manager, you can be sure of this: Your dream condo investment just might keep you up at night.

Fees

Be sure to ask what is included in the HOA fees and find out the delinquency rates of present owners. A portion of your HOA fees should be designated toward reserves and you should find out how much is allocated to reserves. You should also review the balance to confirm it is sufficient to cover things like roof repair and replacement, mechanical systems, façades, and other large capital improvements?

If people aren’t paying their association fees on time, it could be a sign of owner discontent or an indication that the association might be underfunded. Either way…it’s a red flag. If reserves are insufficient to pay for large expenses or capital improvements (or if reserves have already been designated for another planned expense) the HOA will assess an additional fee on the condo owners. This is called a “special assessment.” The seller should be able to tell you if any special assessments are planned, but do not rely solely on this information.

Ask to see all board minutes within the previous 12 months and ask to talk with the HOA treasurer. Find out if there is any pending litigation either by the HOA or against the HOA as these can often result in a special assessment for legal fees or damages. It is also a good practice to compare the association fees to those of similar nearby complexes. Are they too high or suspiciously low? Keep in mind that complexes with pools, gyms and other amenities may have higher maintenance and liability insurance costs.

High-rise comdominium towers typically have more complex mechanical systems such as elevators and HVAC systems that usually require extra reserves and maintenance fees. On the other hand, low-rise and single story developments may have extensive grounds that require landscaping and repaving. You might also ask to see two to three years of HOA fee history so that you can see how they are trending. Have they gone up significantly? Will they continue to go up? These are all good questions to ask of the seller or of the HOA treasurer. If the seller is a bank, you won’t learn much so talkig with the HOA Treasurer is a must!

Reserves

If the fees are low in comparison to nearby complexes, ask why? In newer condo and townhouse projects, builders sometimes charge lower fees to entice buyers. Yet, once the units are sold and the property is turned over to the HOA, the fees increase significantly in order to cover the costs of maintenance and reserves. Ask if the community has done a reserve-fund review in the past five years.

According to Lester Giese, the author of The 99 Best Residential & Recreational Communities in America, he recommends the following formula: If the complex is one to 10 years old, the reserve fund should have 10% of the cost of replaceable items (roofs, roads, tennis courts, etc.). Between 10 and 20 years old, the repair fund should be at 25% to 30%. At 20 years, that amount should be 50% or above. Residents who brag that they don’t pay much in maintenance may be in a complex that either is not being kept up well or is living

Liens

One thing to be careful of is that the HOA may place liens on units for non-payment of fees and seek a deficiency judgment against any of the unit owners for non-payment. You could be on the hook for the seller’s delinquency. A title report should disclose any liens placed on the unit you are buying. Don’t assume, however, that the condo association will put a lien on all outstanding fees, and that it will therefore appear in the title report. You must get a guarantee from the seller that all fees are paid as agreed as well as an estoppel letter from the HOA. A good title company or closing attorney can help you with this but be sure to make the request.

Condo docs

State governments require condo developers to file a declaration with the local county, which describes the condominium project, establishes a homeowners association and either refers to or includes the bylaws. The bylaws govern how the association should be run, such as the number of meetings per year, required votes, and the election of directors and officers. The declaration may contain covenants, conditions and restrictions (CC&R’s) which are rules specifying how condo owners may use their property and the common areas. These rules are binding on all purchasers. Once the developer hands the project over to the HOA, additional rules can be added through voting (according to the bylaws established).

CC&R’s and condo regulations limit the rights of property owners, but with the intention of retaining and improving the value of the property in the subdivision or project. Possible restrictions could be pets, holiday decorations and home businesses.

You should be sure to get a copy of the declaration, the bylaws (if not included) and all rules and regulations established by the condo association to make sure you are aware of any restrictions that will conflict with your intended use of the unit.

A good friend failed to do this before his purchase and then learned that the association had to approve all new tenants, his investment unit sat vacant for over a year and a half because their requirements were so strict. He eventually lost the place because he could no longer afford to make payments on a vacant condo.

Renting, Resale & Financing

Not only should you make sure you are aware of and willing to accept the restrictions imposed by an HOA, you need to ensure that the rules are sufficient to maintain your investment objective and resale value of the unit. If the tenant population is over 10%, there should be clear rental policies, either listed in the bylaws or appended as an amendment. Will the management company find tenants for you? Are you allowed to find your own? If the management company does it, do they get enough good tenants? You might want to ask other tenants or owners about their experience. In addition, ask to see the association’s lease, and have a real estate attorney review it to protect you.

An important thing to consider is that an association can change its bylaws to prohibit or restrict renting at any time. The more owners who rent, the less chance that will happen. More importantly on resale, a lender may consider all units in a condominium project that allows too many rental units to be investment property. For example, if the complexes rules allow 30% or more units to be rented (even if they aren’t actually rented) lenders could deny potential buyers a home loan for an owner occupant and will instead offer an investment property loan that may require a lower loan-to-value ratio and a higher interest rate. If a rental restriction is not in place, or if there is room for the HOA to adjust the level of rentals, your ability to sell the unit later could also be impaired.

Caveat Emptor

Buying a condo or town home may seem easy compared to buying a single family house. But in many ways, it carries a higher level of risk and requires more due diligence on the part of the purchaser. Just as you might when purchasing a single family house, a home inspection by a reputable and knowledgeable in inspector is recommended. For owner occupants and tenants condominiums and town homes offer many benefits such as on-site amenities, low maintenance and convenience. Condominium and town home living often provides a desirable lifestyle for many given their tendency to be located in pedestrian-friendly neighborhoods or other urban environments. These benefits however, don’t always translate to an ideal investment. It is always up to the investor to perform their due diligence, examine the paperwork thoroughly, ask lots of questions in order make an informed decision before you buy.

After the fact is a tough time to learn and you don’t want to ever find yourself at the mercy of the Greater Fool Theory.

Happy investing,

Augie

Submit Your PACT Coaching Application Today!

Good morning friends,

I’ve received a few emails, and YES, I am currently accepting PACT Coaching Applications! The 2010 session begins in early January, and spots are available on a first-come, first-serve basis. If you’re ready to have a supernatural year and jump-start your real estate investing business, I strongly encourage you to visit the link below to receive your application today.

Visit:
http://www.pactprosperity.com/application

I look forward to seeing you on the other side! (If you have any questions, check out the link above. There’s a short video explaining the program on that page.) To your success!

Buy Your Primary Residence With Creative Investing Techniques

I recently received a question via email asking whether some of the principles discussed in this Real Estate Investing Guide can be applied to sales and purchases of a primary residence.  The simple answers are, “yes you can” and “yes you should.”  I’ve included the original email as well as my response, but have removed personally identifiable information in order to protect the innocent.

Hi Augie …My question may be too involved (I may not be able to provide enough details for more than a general answer), but let me give it a whirl. I read two of your articles: (a) What Everyone Needs to Know to Manage in This Market, (b) Reality Check for Real Estate Agents, Brokers and Investors. Very good articles, but the way! Perhaps a dumb question, but could these same principles be applied to a personal residence? Briefly, we have been trying to sell our home for about 6 months. We would like a bit larger home on acreage. Your articles intrigued me. I don’t want to do anything foolish from a financial perspective, but have often wondered if there isn’t a creative (yet sound) way of doing things to make this transition. I see the value in applying this to investments, but wonder how this would apply to a home that you plan to live in for the long term (at least that is the intent).

Thank you for any help or advice you can provide.

Sincerely,
Your Reader

Dear Reader-

Based on the limited information you provided, it sounds as though you currently own your home and are looking to trade up in terms of living space and acreage.  The market is slow and you’ve been trying to sell for 6 months.  This can be a particularly good time to do this because as markets around the country recover, higher prices/valued properties will rise by the same general percentage.  The good news is that that percentage will represent more dollars.  As an example, when a market rises over time by 10 percent, a house originally valued at $100,000 will increase in value by $10,000 while a house originally valued at $400,000 will increase by $40,000 with no more effort.  It is just the rising tide of appreciation raising all boats.

If I were in your current situation, I’d likely offer my home for sale with terms such as a some reasonable percentage (I usually use 3 to 5%) down with a reasonable monthly rental payment (preferably enough to cover your current expenses).  This is basically a lease with an option to buy, also known as lease purchasing a home.  I’d give the buyer up to 3 years to find their own financing and cash me out.  There is a home study course available www.CreatingWealthUSA.com, by the way.

You could also structure the transaction as a lease purchase whereby you’d rent the property until the purchase is completed at a predetermined date. In either case we make the Option Fee or Down Payment (whichever applies) non-refundable.  If someone comes along with a large down payment (say 20%) you might be willing to sell them the property using a wrap around mortgage where they will pay you monthly and you will continue making payments on any underlying mortgage.  Please be sure to use a knowledgeable real estate attorney or escrow agent to close the transaction.  You might also consult your tax advisor regarding any income tax considerations.  Additionally, in these examples it is your responsibility to pre-screen the prospective buyer just like a bank would.  Do they have the financial mean to make the payments?  How is their credit, does it need repair in order to qualify for a mortgage in the next 12 to 36 months?

As far as buying a new property, you could advertise for a swap in your local paper.  “Situation wanted, looking for  3 to 10 acres in exchange for immaculate __ bedroom/ ___ bath home in lovely neighborhood.  Willing to discuss terms to satisfy both parties.” Who knows, you might attract someone who’s been trying to sell a house with acreage for 6 months without any luck.  You just have to find each other.  You might also look for a lease option of your own with a motivated seller.  If you do this, make your term longer on the property you’re buying than the one you are selling.  Check with your local REIA (Real Estate Investment Association), sometimes their members have wholesale properties, owner financing deals and lease option properties available.  If you work directly with a seller than the sky is the limit in terms of creativity.  Assuming you have equity in your current home, you might be able to use it as your down payment or option fee on the new property by giving them a note secured by that equity payable when your buyer exercises their option. This way you don’t even have to come out of pocket for the option fee or down payment (depending on the transaction you create). Whatever terms you both agree to will be what makes your deal work.  Keep an eye out for probate deals, free and clear properties and other generally motivated sellers.  They are the best candidates for making creative deals work.

What do you think?  Would you structure the purchase of your primary residence like a real estate investment?